Carbon emission trading

Carbon emission trading (also called carbon market, emission trading scheme (ETS) or cap and trade) is a type of emission trading scheme designed for carbon dioxide (CO₂) and other greenhouse gases (GHG). It is a form of carbon pricing. Its purpose is to limit climate change by creating a market with limited allowances for emissions. This can lower competitiveness of fossil fuels and accelerate investments into low carbon sources of energy such as wind power and photovoltaics. Fossil fuels are the main driver for climate change. They account for 89% of all CO₂ emissions and 68% of all GHG emissions.^: 12

Emissions trading works by setting a quantitative total limit on the emissions produced by all participating emitters. As a result, the price automatically adjusts to this target. This is the main advantage compared to a fixed carbon tax. Under emission trading, a polluter having more emissions than their quota has to purchase the right to emit more. The entity having fewer emissions sells the right to emit carbon to other entities. As a result, the most cost-effective carbon reduction methods would be exploited first. Carbon emissions trading and carbon taxes are a common method for countries in their attempts to meet their pledges under the Paris Agreement.

Carbon emissions trading schemes are in operation in China, the European Union, and other countries. However, they are usually not harmonized with any defined carbon budgets, which are required to maintain global warming below the critical thresholds of 1.5 °C or "well below" 2 °C. The existing schemes only cover a limited scope of emissions. The EU-ETS focuses on industry and large power generation, leaving the introduction of additional schemes for transport and private consumption to the member states. Though units are counted in tonnes of carbon dioxide equivalent, other potent GHGs such as methane (CH₄) or nitrous oxide (N₂O) from agriculture are usually not part these schemes yet. Apart from that, an oversupply leads to low prices of allowances with almost no effect on fossil fuel combustion. In September 2021, emission trade allowances (ETAs) covered a wide price range from €7/tCO₂ in China's new national carbon market to €63/tCO₂ in the EU-ETS. Latest models of the social cost of carbon calculate a damage of more than $3000 per ton CO₂ as a result of economy feedbacks and falling global GDP growth rates, while policy recommendations range from about $50 to $200.